Land loans: 3 things you need to know before buying land

If you are buying land instead of an existing house because you want to build from scratch, you may need a land loan. This will cause more problems than getting a normal mortgage. On the one hand, no house can be used as collateral for land loans.

Obtaining land financing creates a series of different barriers for potential buyers. Before buying land, you need to consider the following three things.

Key points

  • Compared with applying for a home mortgage loan, obtaining a land loan creates a series of different obstacles.
  • The lender needs to investigate the boundary, you need to check the zoning and land use restrictions of the property, as well as the right to use public utilities and public roads.
  • The more the land is improved, such as a lot that is ready for construction, the lower your borrowing costs will be.
  • The best sources of loans include seller financing, local lenders or home equity loans.
  • Rural land may be eligible for USDA subsidized loans.

1. Land base: boundaries, zoning, access

First, it is important to know what the potential purchase requires. This is why it is so important that the surveyor mark the boundaries and prepare everything on the paper for submission to the lender. Another important detail is to carefully check the zoning and land use restrictions.

For residential areas, the use of public facilities is an important factor. Preparing water, sewer, power and cable connections can save a lot of time, money and hassle. Similarly, access to public roads may be a key issue, because if the public road is not yet available, the buyer will have to obtain a permanent easement to gain access to the public road.

It is also wise to check with the local planning department to understand the future of nearby communities. New parks on the streets can increase the value of real estate in the next few years, while new highways or sewage treatment plants are unlikely to do so.

Since buying land is different from buying a house, it is best to work with a real estate agent who specializes in this type of transaction.

2. Land planning use: immediate construction, need for improvement, speculative investment

The terms of the loan—such as the down payment and interest rate—usually depend on the intended use of the land, as this is directly related to the bank’s risk exposure. In this way, obtaining a land loan is always more difficult than buying an existing house, because the existing house provides the bank with direct and tangible collateral, and the new building has more moving parts that can go wrong.

Starting with existing houses, the next step in the bank’s confidence ladder is to purchase plots that are ready to be built and intend to begin construction of the main residence immediately. In the process, some things may go wrong, cause delays or increase costs, but in the eyes of the bank, the timetable is still controllable. The required down payment is usually in the range of 15% to 25%.

Finally, there is no concrete plan to build anything on the original land, which is basically a speculative investment. For example, such a project may involve the purchase of land in order to build a new highway nearby. The hope is that when the expressway is completed, this piece of land will be very attractive for developers to build a new community that is convenient for commuting to the city. The land can then be sold to developers for a considerable profit. These loans may require a down payment of up to 50%.

Unimproved plots are those plots that do not have the basic services required. It is very common to encounter unforeseen problems and cost overruns, which may extend the procurement time by several months.

3. Land loan options: looking for financing

In view of the above issues, you may need to further look for financing for the purchase of your land on acceptable terms. Try these sources:

Seller financing

This may be a good choice for favorable terms, especially if the seller is eager to unload the land and the market is cool. Since this is an agreement between two ordinary citizens, everything from down payment to interest rate can be negotiated. It is important to have a lawyer review the documents before signing any documents to avoid loopholes and unpleasant surprises on either side.

Local banks and credit unions

Compared with large giants, local banks and credit unions are generally more optimistic about land loans. Because of their local knowledge of the property, they may also provide better terms. Nevertheless, potential borrowers still need to provide a loan plan that includes land specifications and plans, as well as personal financial information to prove their credibility.

USDA loan

If banks and credit unions do not provide funds, how can buyers buy land? If the property is rural and agricultural, the buyer may receive federal assistance. The United States Department of Agriculture (USDA) provides a variety of subsidized loans with minimum requirements and preferential terms.

Home equity loan

Buyers who own an existing property and have very little debt may want to consider home equity loans. This type of loan takes advantage of existing property rights and provides better terms than any conventional construction or land loan.

Bottom line

Financing the real estate to build a dream home is much more complicated than applying for a mortgage. The lender needs to investigate the boundaries, you need to check zoning and land use restrictions, and whether you can use utilities and public roads. The more the land is improved, the lower your down payment and borrowing costs will be.

The best options for financing land purchases include seller financing, local lenders, or home equity loans. If you are buying a rural property, be sure to research whether you are eligible for a USDA subsidized loan.

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